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What’s the catch? Trade-off is a better word: You may not be able to deduct as much compared with the regular method. The IRS says the average home office deduction has been around $3,000. So consider the value of your time against potential tax savings if you believe you’re eligible for more than the $1,500 cap.

Before you start spending your refund, however, there are a few rules you need to heed.

A room or defined area of your home that you use exclusively and on a regular basis for business and that meets either of these uses:

It’s your principal place of business, or

You see clients, customers, or patients there.

Exception to the “exclusive” rule: If you use your home as the sole location of your business and store products there, the room or area where you store products can be used for other things. Say you use a room in your basement to make and store jewelry that’s also a TV room. If it’s the only fixed location of your business, you can use it to also watch TV.

What If You’re on the Road a Lot?

You don’t have to do all your work from home to take the home office deduction. If you’re an outside salesperson, you probably spend most of your work time elsewhere. But the home office has to be essential to your business, and you must spend substantial time there. If you do your billing and other office work from your home office, and there’s no other location available to perform these functions, your home office should qualify for the deduction.

You can also qualify for the deduction if your employer requires you to work from home, as long as you don’t charge your employer rent.

A big catch: You must maintain the at-home office for your employer’s convenience, not your own. If you use your home office to finish reports at night or on weekends because you don’t want to work at your desk in your office downtown, you can’t claim the home office deduction.

But if your employer doesn’t have a headquarters and everyone works remotely, you’re good to go.

Also Covered Under the Tax Break

Separate structures on your property, like a detached garage you’ve converted to an office or studio.

Unlike an office inside your home, a separate structure doesn’t have to be your main place of business to qualify for a deduction. That’s because the IRS believes your family is less likely to use a separate structure as a part-time play area or den, says Mark Luscombe, principal analyst for tax and consulting at CCH.

You can’t depreciate your home office, and your deduction is limited to your gross business income less business expenses.

If you use this deduction, you can still claim the deductions every homeowner gets, like mortgage interest, real estate taxes, and casualty losses. Put those on Schedule A.

Using the standard home office deduction won’t stop you from taking the deductions for other business expenses unrelated to your home, such as advertising, supplies, and employee wages.

You don’t need to keep track of individual expenses with this option. You do with the actual cost method.

2. Actual costs, which you list on Form 8829. To use this method, you figure the proportion of your home’s overall space devoted to your office and use that to calculate how much of your overall home expenses went toward your home office.

Example: If your office is 300 sq. ft. and your home is 3,000 sq. ft., your office takes up 10% of your home. So you can deduct 10% of your utility, mortgage interest, property taxes, and other home expenses. However, certain expenses that aren’t related directly to the home office, such as lawn care, aren’t included in the calculation.

Not sure how big your house is? Check the documents you received when you bought your home — there’s probably a detailed rendering — or measure the outside of your home and multiply length times width.

Do You Have to Stick with the Same Deduction Method Each Year?

Nope. Each year, you get to decide whether to use the standard or the actual-expense deduction.

What Can You Deduct When You Use the Long Form?

If you’re using Form 8829 to report your actual expenses and you’ve figured out what percentage of your home you use for business, you can apply that percentage to different home expenses. These include:

Mortgage interest

Real estate taxes

Utilities (heating, cooling, lights)

Home repairs and maintenance (so long as they benefit both the business and personal parts of the home)

Homeowners insurance premiums

Just take each expense and multiply it by your home office percentage to get the amount you can deduct as a business expense. So if you spend $150 a month on electricity, and your home office takes up 10% of your home, you can deduct $15 a month as a home office expense. That adds up to a $180 deduction per tax year.

Important limitation: Your home office deduction can’t exceed the amount of income you generate from the home office. So if you spend some of your work time on-site with a client and earn $1,500 there, you can’t claim more than $1,500 because it exceeds what you made at home.

Save bills or cancelled checks to prove what you spent in case of an IRS audit. Also, only repairs, like to the furnace, can be expensed; improvements must be depreciated.

Don’t Forget Depreciation

Depreciation is based on the idea that everything — even something like a home — wears out eventually. If you’re using the long form, figure home office depreciation by calculating the tax basis of your home:

1. Add the purchase price to the cost of improvements.

2. Subtract the value of the land it sits on.

3. Multiply that cost basis by the percentage of your home used for work. This gives you the tax basis for your home office.

4. Divide by 39 years.

For example:

Purchase price: $100,000

Value of land: $25,000

Cost basis: $75,000, plus cost of improvements you’ve made

Tax basis: $75,000 x 10% = $7,500

Depreciation deduction: $7,500/39 years*

*Usually, depreciation deductions for a home office are figured over a 39-year period. There are caveats. For instance, if your business opened after Jan. 1 in its first year, you need to calculate a factor of 39. For a crash course, read IRS Publication 946 or talk to a tax pro.

Keep in mind that depreciation deductions on your home office may increase the amount of profit on a home sale that’s subject to taxes. Most taxpayers don’t owe income tax on up to $250,000 of profit if you’re a single filer, $500,000 for joint filers. Consult with a qualified tax professional on how depreciation deductions affect your tax liability when you sell.

If you provide in-home daycare services for children, the elderly, or disabled persons as a licensed or authorized business, you don’t have to use the home work space exclusively to take the home office deduction.

You calculate your deduction by dividing the number of hours you used your home workspace to provide daycare services during the year by the total number of hours during the year.

For example, if you do daycare 40 hours a week for 50 weeks a year, that’s 2,000 hours a year, divided by the 8,760 hours in a regular year equals 22.8%. So you could take 22.8% of the $5 per sq. ft. simplified deduction for your daycare workspace.

This article provides general information about tax laws and consequences, but shouldn’t be relied upon as tax or legal advice applicable to particular transactions or circumstances. Consult a tax professional for such advice.

Track Your Progress

Great questions, Tom. Please do contact a tax pro to discuss your particular circumstance as we can’t provide specific tax advice. A few tips, however: The costs of constructing and decorating the second office space wouldn’t likely be deductible. But if the building is used for business, in whole or in part, the costs of materials and labor used to improve it would be added to the basis of what you paid for the building, and that total is the new basis for depreciating the office. As to the allocation, it really depends on if the entire building were being used in the business or not. If yes, there would be no allocation necessary, as the entire building could be depreciated. But you say the building is part barn and part workshop. That’s where a tax pro would come up with a strategy for you on how to handle it. Good luck.

Posted by HouseLogic on March 13, 2014

I own a single member LLC and work from home. Although, I do have a dedicated room for my business activities there are still too many distractions. I have a large building on my property that's approximately 200 feet from my home I use as part barn and part workshop. However, there is third section of the building that is not used and would be an excellent place to work from but would require construction, heating, air and decorating to make it a functional office. My questions are, can I deduct the construction and decorating cost (i.e a window/wall unit HVAC, paint, wall paper etc.)? Also, since this is a separate building how would I use square footage for tax purpose or should I just just use the new 1500.00 rule that was implemented in 2013?

Posted by Tom on February 27, 2014

Lorry, please contact a tax pro about your specific circumstances. Generally, if you operate a tax-exempt organization from your home, you’re not allowed to take a home office deduction because it isn’t a for-profit trade or business -- no income is earned from a tax-exempt organization, so there can be no deduction. The law limits the home office deduction to the amount of income from a business. However, the person operating the organization might be able to rent a portion (such as a room) of the home to the organization as an office. The organization would pay rent to the home owner and the owner could deduct part of the expenses of the home to offset the income from the rental payments. In some circumstances, the person renting the office to the organization might be able to deduct more than the income from the rent.

Posted by HouseLogic on February 11, 2013

Can a person who operates a 501[c]3 tax exempt business in a portion of their home exclusively for the nonprofit deduct a portion of their utilities such as electric use be within the law to make that cost deduction?

Posted by Lorry on February 09, 2013

Tony, consult your tax pro about your particular situation. In general, if you claim a home office deduction and, as part of that deduction, claimed depreciation for your home office, then you can’t take the full capital gains exclusion on the home sales profit. Instead, you have to subtract from the profit the amount of depreciation you claimed during all the years you took the deduction. And that amount is taxable.
Suppose you claimed a home office deduction of $1,000 for each of 2011 and 2012; $250 of that amount each year is depreciation expense. You sold your home on Jan. 1, 2013, for a profit of $10,500. Assuming you’re eligible for the cap gain exclusion, you’d have to reduce what you can exclude by the amount of depreciation – in this case $500 ($250 x 2). That leaves $10,000 you can exclude.
Whether taking a home office deduction makes you more prone to an IRS audit, no one outside the IRS can say with certainty. However, many tax professionals would probably say that it could increase audit risk. But, if you follow IRS rules for taking the deduction, it should stand up under the scrutiny of an audit.